Peer to peer lending is a new form of lending money suitable for both those with money to lend (p2p lending), and those looking for peer to peer loans (p2p borrowing).

Peer to peer lending simply removes any financial institution from the equation, so you could lend money to your neighbour, charge a rate of interest and a time scale, and wait for that money to be repaid.

Peer to peer lending sites like Zopa and Funding Circle merely act as the administrators, helping you find people to peer to peer borrow from, or those who you can offer peer to peer loans to.

By cutting out the banks those looking to lend are able to get slightly lower rates whilst those looking to save money by lending should get a slightly improved rate.

Peer to peer lending sites are therefore growing in popularity for both savers and those looking to lend, but it’s important to remember that they’re not savings accounts.

There isn’t the same protection for your savings in the event of a disaster (like the Financial Services Compensation Scheme for banks), but there are numerous safeguards in place.

Those borrowing money are credit-checked and receive a risk rating that informs at what rate they can borrow, similar to a bank. Crucially if you run into trouble recovering a loan the websites act on your behalf.

Zopa is perhaps the most established peer-to-peer lender in the UK and has tens of thousands of active members.

For savers it works just like a bank. Choose how long you can lock your money away and pick the rate, and Zopa will spread your savings among those it lends to (other members) to spread the risk.

To ensure lenders get their full loan amount Zopa uses a fund (called SafeGuard) which covers any shortfall from bad debts in your portfolio. As long as there’s enough money in SafeGuard you’re covered, so the only risk is if there are too many bad debts at once.

Funding Circle is the most traditional peer-to-peer site in that you can pick individuals or businesses to lend to based on what they’re proposing. Alternatively you can spread the risk in a savings fund just like Zopa and Ratesetter.

Ratesetter is a more traditional approach to saving, and does everything it can to seem like a savings account for those willing to put their money away. If you are looking for a return on your savings then all you really need to compare between the two is the rate.

Just like Zopa, Ratesetter has its own provisional fund to cover any shortfall as a result of bad debts. .

If you’re looking to save money then p2p lending may well be a sensible option, but there’s a few things you need to be aware of.

First of all, how long are you prepared to have your money locked away for? Peer-to-peer lending only really works if you’re happy to have your cash unavailable for one, three or five years.

If you’re looking for instant access then an instant-access savings account, some ISAs, or even some current accounts may be a better option. While some peer-to-peer sites will let you take out money quickly you will lose a lot of interest.

The next thing you need to be aware of is security. Unlike in its early days peer to peer lending sites in the UK are now regulated, but there’s no overarching compensation scheme in case they go bust.

As discussed above, the big peer-to-peer sites have a separate emergency fund they use to cover bad debts and shortfalls in repayments. However, the smaller lenders don’t have these and they do have limits.

If one of the sites were inundated with bad debts and its scheme couldn’t cover you, then you could lose cash.

For most savers though the ultimate test will simply be the rate offered. Compare p2p lending rates against those offered for long-term savings by the banks and make your choice – just remember to take the fees into account.

If on the other hand you’re looking to borrow money, then peer to peer lending sites may offer a very good alternative. Unlike lenders you won’t have to worry about losing cash, but you should carefully read the debt repayment rules depending on what site you’re on, and what lender you borrow from.

Set up a Direct Debit to cover regular repayments and keep careful track of the duration of the loan. Then it’s simply a case of searching for the best rate.

Compare peer-to-peer loans

Compare a number of peer-to-peer and other personal loans on our comparison table.

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